Average and Marginal Revenue

Average revenue is equal to the price of the product, if there is no price discrimination (price discrimination occurs when a firm charges different prices to different economic groups, such as students and senior citizens). In this case, the average revenue curve is the same as the demand curve.

Unlike the purely competitive firm’s marginal revenue curve, the monopolist’s marginal revenue curve is different from its demand curve. Because the firm lowers its price when it wants to sell more products (and vice versa), marginal revenue decreases as output increases. Therefore, the marginal revenue curve lies below the demand curve. At any output, except for the first output value, marginal revenue is less than price and the average revenue.

The following example illustrates this.

 Quantity Price Total Revenue Average Revenue Marginal Revenue 100 \$0.50 \$50 \$0.50 – 120 \$0.45 \$54 \$0.45 \$0.20 140 \$0.40 \$56 \$0.40 \$0.10

The monopolist sells 100 newspapers at a price of \$.50. It sells 120 newspapers at \$.45, and 140 newspapers at \$.40 per paper. When the price changes to \$.45, marginal revenue decreases to \$.20 (marginal revenue is the increase in revenue divided by the increase in quantity, or \$4/20). When the price changes to \$.40, marginal revenue decreases to \$.10 (\$2/20).

Another Example

Below is another example of marginal and average revenue calculations for a monopolist.

Consider the following monopolist’s demand curve. In order for the monopolist to increase its sales, it must lower its price.

 Quantity per Month Price 0 \$40 1,000 \$35 2,000 \$30 3,000 \$25

Copying the demand data above, and calculating the monopolist’s total, average, and marginal revenue for the first three rows, we get:

 Quantity per Month Price Total Revenue Average Revenue Marginal Revenue 0 \$40 \$0 – – 1,000 \$35 \$35,000 \$35 \$35 2,000 \$30 \$60,000 \$30 \$25 3,000 \$25 ? ? ?

Problem: In the table above, can you complete the row in which the quantity is 3,000?

Solution:

 Quantity per Month Price Total Revenue Average Revenue Marginal Revenue 0 \$40 \$0 – – 1,000 \$35 \$35,000 \$35 \$35 2,000 \$30 \$60,000 \$30 \$25 3,000 \$25 \$75,000 (Q times P, or 3,000 times \$25) \$25 (TR divided by Q, or \$75,000 divided by 3,000) \$15 (Change in TR divided by change in Q, or \$15,000 divided by 1,000)

Graphing the Monopolist’s Demand and Marginal Revenue Curves

If we graph the quantities from the above table against the prices and the marginal revenue values, we get a graph that looks like the one in the diagram below. Because the monopolist is the industry, the monopolist’s demand curve is the industry demand curve. An industry demand curve, as we saw in the chapter on supply and demand, is downward sloping. Because there are no close substitutes for this product, the demand curve is relatively steep, or inelastic.

The marginal revenue curve is below the demand curve, because the monopolist lowers its price as it sells more products.

In the next section, we add cost curves to the tables and graph above in order to identify the monopolist’s profit-maximizing output and price.